European governments must rapidly commit to fiscal union or a partial break-up of the euro to prevent a "fundamental erosion" in demand for the region's debt, Pimco, the world's biggest bond investor, has warned.

I don't see the Germans opting for a real fiscal union. Do you? It seems imprudent.

The euro project was flawed from the start and the current generation of European leaders has failed to address its fundamental problems, Jacques Delors, the architect of the single currency, declares today.

There is in the end no way of squaring this circle. The euro zone ties a country with a deeply-ingrained fear of inflation and a longstanding commitment to thrift to a bunch of neighbours most of whom have a historic tolerance of inflation and feckless spending. It is a wonder this marriage has lasted as long as it has. Now that the time has come for divorce, you can’t help thinking it is a pity they didn’t think to draw up a prenup.

The euro as presently constituted is not going to be saved. Angela Merkel doesn't want to admit it. But so far it is hard to see the German position as leading to anything but a euro break-up. So time to get on with it. Ignore Merkel's rhetoric about wanting to save the full euro zone. Look at the actions of her government and of the ECB. The only option possible is break-up.

Break-up is sensible anyway. There's no way to either grow out of the crisis. Southern Europe is headed back into recession. Southern European sovereign defaults threaten to cause a massive wave of bank defaults. The southern Europeans need to do defaults in their own currencies. Also, southern European labor markets are incompatible with the euro.

Why worry about asteroid strikes or a massive volcanic eruption when you can worry about the collapse of the euro currency zone? This isn't one of those disasters that come on suddenly. It has a plot that has been building up for years. Though for most of that time the very idea that we were in a disaster plot was denied by the main writers. Now, however, too many plot complications have built up to the point where a disaster cliff hanger is clearly in view. Any outcome looks pretty bad and some of them are "buddy, can you spare me a dime?" doozies. Even collapse of the European Union is being mooted.

Europe is a pretty scenic and culturally rich place in which to have economic collapse, rioting in the streets, and general chaos. If it happens excellent news video feeds will boost ratings more than a terrorist attack. The British government is already preparing to deliver life support to Brits caught inside of failed states. Maybe NATO troops should be pulled out of Afghanistan in order to do nation-building in Europe?

A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time.

“It’s in our interests that they keep playing for time because that gives us more time to prepare,” the minister told the Daily Telegraph.

Time to move US Marines helicopter carriers into position to evacuate Americans from Italy, Spain, and Portugal to England? Stock up US military bases with food? Or maybe dollar ATMs?

Also, there've got to be shady subplots of conspiracies afoot. Have the Bilderbergers have been plotting (benevolently of course) for this outcome in order to undermine Brussels as a competing power center? Is the Trilateral Commission on board? The Illuminati? Name your favorite group to hate or fear. They might have a role.

Now that even Germany – Europe’s most creditworthy country – is struggling to raise cash, there’s no haven left within the 17-member common currency. On Friday, two more countries, Hungary and Belgium, saw their credit ratings downgraded as Italy struggled with a bond auction that saw long-term borrowing coasts soar to unsustainable levels.

A survey by Barclays Capital of almost 1,000 of its clients, published Wednesday, shows almost half now expect at least one country to leave the euro zone. And a mere 3% are expecting a workable solution to the crisis within the next three months.

Banks including Merrill Lynch, Barclays Capital and Nomura issued a cascade of reports this week examining the likelihood of a breakup of the euro zone. “The euro zone financial crisis has entered a far more dangerous phase,” analysts at Nomura wrote on Friday. Unless the European Central Bank steps in to help where politicians have failed, “a euro breakup now appears probable rather than possible,” the bank said.

It is hard for me to see how the United States avoids a recession as Euro countries default, reestablish their currencies in a hurry, and banks fail.

There is no way to have just a little debt restructuring for Italy. If Italian debt involves serious credit risk – i.e., a nonzero probability of default – then all sovereign debt in Europe will need to be repriced, downwards. There is a notion that Germany will remain a safe haven, but even that is far from clear. According to the IMF, gross government debt in Germany will be 82.6 percent of GDP at the end of this year (Statistical Table 7 of the IMF’s Fiscal Monitor; the net government debt number for 2011, in Statistical Table 8, is 57.2 percent). Reports of German fiscal prudence have been greatly exaggerated.

There is no way that the German policymakers or the German public will do well in the event of a major sovereign credit disaster. Credit would tighten across the board. German exports would plummet. The famed German social safety net would come under great pressure. If Germany had to call in the International Monetary Fund for advice, even informally and behind the scenes, how would that feel?

Will the Germans opt for inflation to hold the EU together? Or will southern members reestablish their currencies and then pursue inflationary monetary policies? In the latter scenario the euro's exchange rate will probably rise, putting the brakes on German exports and putting Germany into a recession.

I am seeing reports of 7.7 on the Italian ten-year bond, over eight percent on the two-year bond, 6.5 percent on the six-month note, and so on. Here is one account.

Maybe these markets simply will shut down soon. There is so much talk about what the Germans should do, but I don’t see the viable options. With Germany’s own credit status now in doubt, eighty percent debt to gdp ratio, massive welfare state, and unfavorable demographics, are they supposed to endorse — going to endorse — ten or fifteen percent price inflation for a few years’ time, all with no guarantee of reforms in the economically weaker countries? And is that inflation then followed by a subsequent deflation? Or does it continue forever? And would Germany have to move to a regime of wage flexibility for the professions too? How politically feasible is that? I don’t see how the Germans benefit from going down this road, even if you think, as I do, that the alternatives are quite dire.

7.7% is not a stable interest rate for any of the southern European countries. They either have to default or get bailed out. Since the bail-out option seems unlikely default seems more likely. But default means bankruptcy of many banks that hold sovereign debt. That drives already poor governments to try to bail out their banks. That, in turn, drives these governments to want to leave the Euro and regain their own currency with their own central bank to bail out the banks

You can find lots of commentary on why Germanyshouldsavethe euro in its present form with all current members. But such a move would be incredibly expensive and just kick the ball down the road into an even bigger crisis. Why? A root cause: Spain Labor Market Incompatible With Euro. Read that. As long as southern European labor markets basically require periodic bouts of inflation the northern and southern European countries should not be in the same currency zone.

No, what this is about is the markets starting to bet on what was previously a minority view - a complete collapse, or break-up, of the euro. Up until the past few days, it has remained just about possible to go along with the idea that ultimately Germany would bow to pressure and do whatever might be required to save the single currency.

Many people assume that the tipping point will come when one country — most likely Greece — leaves or is ejected from Europe’s monetary union. But the scenario that worries Eurocrats is different. They fear that a country could leave the European Union itself.

This is by no means an irrational anxiety. Under E.U. law, it would be much easier for Britain to leave the European Union than for Greece to leave the euro zone.

Ferguson sees Britain's exit from the EU as more probable than southern European countries leaving the euro currency zone. I'm not persuaded. Even if the Germans give large sums of money to the southern European countries and agree to a monetary policy that causes sustained inflation to inflate away some of the debt what happens 5 years hence? Mechanisms in the labor markets and politics of southern European countries will gradually cause them to become uncompetitive again.

Europe is, of -financial- necessity, sliding towards a fiscal and subsequent political union (and yesterday was a big step). A union that has zero chance of being accepted by its members. That is how we recognize that this is the beginning of the end. Without the extended powers of the EFSF, an outright Greek default would have been unavoidable. With the revamped facility, there can be a few more months (or is it even just weeks?) of pretending. And then, German, Dutch and/or Finnish voters will hammer it down.

Will voters in a couple of European states throw up so much opposition to bail-outs aimed at saving the Euro that ejection of some Euro zone members will become necessary? Can the Euro at least be saved for the northern European countries?

PARIS — Europe isn't going quietly. In this season of continental crisis, both financial and existential, French President Nicolas Sarkozy has yelled at European Central Bank President Jean-Claude Trichet. The European Union commissioner in charge of justice, Viviane Reding, has insulted Sarkozy, who has fired back. Leaders of smaller countries have openly complained about German pigheadedness and French arrogance. The Germans and the northern countries call the Greeks freeloaders, liars, and worse; the Greeks have said Germany should return gold and antiquities looted by the Nazis.

I expect Peak Oil and an aging population to make Europe's financial crisis grow in the next 10 years. So I am skeptical of the survival of the Euro, at least with all its current members. It can only survive if the big money elite in Europe decide to bribe and otherwise cajole national leaders to adopt policies to ensure the Euro's survival. It is not clear to me the European elite will decide they want to do that.

The debt crisis in Greece has taken on a dramatic new twist. Sources with information about the government's actions have informed SPIEGEL ONLINE that Athens is considering withdrawing from the euro zone. The common currency area's finance ministers and representatives of the European Commission are holding a secret crisis meeting in Luxembourg on Friday night.

The Spiegel article was meant as a salvo that would sound long-delayed alarm bells. It was intended to raise a small storm of panic as a means of reminding Mrs. Merkel that the crisis so far is akin to a tea party when compared to what will follow if she continues to live in lies.

Who sent this message? Der Spiegel would never act by itself, without coordinating with powerful German policy circles. My sources tell me that these circles are mainly located within the Finance Ministry and, to a lesser extent, in one or two of the larger banks of Germany. In association with Der Spiegel they had been sending tamer messages along similar lines for a while, namely that the Greek debt is not sustainable under the present policy mix (see FT Alphaville's account of that series of messages sent using Der Spiegel as their main conduit).

My take: Too many incompatible economies are in the Euro. The problem runs deeper and longer than the current debt of the PIIGS. In the long run it does not make sense to have so many countries which speak so many different languages (hence low labor market mobility) and which have such different economic systems to get tied up in the same currency zone. But like other dumb things our elites do (e.g. conduct wars that are not in the national interest, run up debts that threaten sovereign debt crises, and prefer lower skilled immigrants) we can't expect reason to appeal to them. The Western countries have destructive policies and due to destructive political and economic cultures.

On Saturday, fellow FDP MP Frank Schaeffler said Germany should constructively support Athens should it choose to leave the euro zone.

Schaeffler was joined by Ifo Institute President Hans-Werner Sinn, who told Sunday weekly Frankfurter Allgemeine Sonntagszeitung (FASZ) that a Greek exit is preferable to permanent fiscal transfusions from German coffers.

How it looks to me: Germany's elites are fighting over whether to keep the Euro intact over all current members. Greece's fate will be decided in Berlin. The more southern European countries that remain in the Euro the more the Euro will be pressed to become like the currencies that those southern European countries used to have (Can you say "inflate to relieve excessively high wages caused by union power"? Sure). Also, Germany will basically be pressured to subsidize these spendthrift societies. So some portion of the German establishment wants Greece out of the Euro to ensure the Euro stays more like the Mark. Makes sense to me.

Business people in the southern countries call it the euro bind. Oscar Turner, who runs a film company in Portugal, explained, “The euro’s great if you’re traveling around, but it’s an absurd idea to have the same currency in a country like Greece or Portugal as in Germany, which has totally different habits and culture.”

The highly indebted countries of the euro zone “can’t grow their way out of debt,” Mr. Turner said, nor can they devalue to make their exports more competitive. “No one in these countries can make the same product for a price that competes” with Hungary, let alone Turkey or China.

Different habits and culture? That's part of it. But let us boil it down to brass tacks: Labor laws make lay-offs extremely difficult and powerful unions (backed by laws even stronger than the Wagner Act which drove so many US airlines and car companies bankrupt) push labor rates up to uncompetitive levels. These countries need the ability to inflate their currencies to lower inflation-adjusted wages.

Mr. Trichet studiously avoided singling out specific countries to blame for the sovereign debt crisis, which emerged because of creeping indebtedness. Instead, he said, a “quantum leap” was needed in the zone’s fiscal and economic governance.

Specifically, he called for a “quasi-federation — not a political federation” to better coordinate “the budgetary surveillance processes and rules that we have.”

Economic governance? What, with a central labor law? Are the Germans really so many in number that they have so many votes in the Euro Parliament to get legislation thru a more powerful European Parliament that would break the unions and undo the labor laws of southern Europe? (Um, no) There's an air of unreality to his thinking. Federation does not solve the problem because it gives the profligate control over the abstemious. Germany mixed in with Spain and Italy is Germany with more of Spain and Italy's laws and their ability to divert more money from Germany.

The only way central rule of Europe could work: Make the non-German states colonies ruled by the Germans. Then the Germans could impose labor law changes that would provide Spain, Greece, Portugal, and Italy with the lower wages, greater workplace discipline, and greater ease in worker firing that they need. You might laugh. But at an economic level Europe would perform better. The Euro elites need to understand that they can not impose German ways over the rest of Europe.

Really, the Euro is broken. The people in Spain and Italy do not want to wake up tomorrow and put away their class warfare attitudes toward the more productive. They want political power over the more productive and want to force up their wages to uncompetitive levels.

Oh, and the British should thank George Soros for helping to keep them out of the Euro.

Stripped to its essentials, the €85bn package imposed on Ireland by the Eurogroup and the European Central Bank is a bail-out for improvident British, German, Dutch, and Belgian bankers and creditors.
The Irish taxpayers carry the full burden, and deplete what remains of their reserve pension fund to cover a quarter of the cost.

Why should reckless creditors be so privileged? Why should the Euro elite stand up for the stockholders of their banks when bank management has made such colossal mistakes? Irish taxpayers are not responsible for this disaster. The EU and the banks and bank regulators are responsible. The stock holders of the assorted German, French, British, and other Euro banks should take it in the chin. Instead Ireland is turning into a big debtor's prison. Nigel Farage gets it right too.

I am skeptical that this deal will last. All it would take is another sharp oil price spike, this time well north of $150 per barrel, to bring down the financial house of cards.

"What would really happen if the euro collapsed?" Jens Witte of Der Spiegel news magazine wrote. "Would it truly herald a return to the good old days … to the much-revered deutsche mark?" Or might it lead instead, he asked, to an era of "chaos and economic depression?"

With more European countries going broke what now?

"The question 'what now?' has become the fundamental question at the heart of Europe," the conservative daily Die Welt wrote in a commentary Monday in which it passionately argued that the government would soon have little choice but to rethink the future of the single currency and its loyalty to the euro.

Eventually one or more countries decide enough is enough and break away or are forced out, reintroducing the national currencies they used before tying their fate to Europe's audacious economic and monetary union.

Unthinkable only a few weeks ago, a small but growing number of experts now believe some version of this nightmare scenario could become a reality for the euro zone if policymakers fail to unite behind a more forceful strategy for saving the euro and address investor concerns about fiscal and economic imbalances.

Imagine the alternative: All the Euro zone countries remain in the Euro. I do not see how they can do that without defaulting on some of their debts. Can the Euro monetary union survive sovereign defaults by some of its members?

What I haven't seen discussed yet: A return to a couple dozen currencies does not make sense. So should the Euro zone break into 2 or 3 zones? Or will the break-up be too sudden and chaotic to allow that to happen? Germany was the obvious core of the Euro and could form the core of a currency union that would also include the Netherlands, Austria, and a few other countries. But which country could serve as an alternative core for a Euro 2 currency? Would France break away with Italy and Spain? Or would France stay in a union with Germany?

European governments and business elites have a lot emotionally, intellectually, and in reputation invested in the Euro. They won't give it up easily. But if Peak Oil hits hard as I expect in the next 10 years then the financial conditions of the weakest Euro members will become so bad that the only way the Euro zone will be able to stay intact will be with debt default and restructuring by some Euro zone members.

Farage is correct in asserting that the Euro zone caused the Irish financial crisis. Ireland needed a more restrictive monetary policy with higher interest rates. The low interest rates made possible by being tied, effectively, to the German economy caused a massive property bubble. Then when the bubble burst the Irish government, under pressure from other Euro zone members to protect their banks, took on much of the failed Irish bank debt as sovereign debt.

Think about that. The Irish banks failed. Their bonds should have been marked down in value. German and other Euro banks foolish enough to lend to them should have taken big losses. But instead the Euro elite pressured the Irish government to foist this debt onto the Irish people. Do I even need to say that the Euro wasn't the designed by the Irish voters and that the Irish voters did not make German bank lending decisions or Euro bank monetary policy decisions? But they are stuck paying the bill for the decisions of Euro elites.

No, the real story behind the euromess lies not in the profligacy of politicians but in the arrogance of elites — specifically, the policy elites who pushed Europe into adopting a single currency well before the continent was ready for such an experiment.

Agree about the arrogance of the policy elites. Then he goes on to portray Spain as fairly prudent before the financial crisis caused the property bubble to burst (though allowing a property bubble to run isn't prudent).

Consider the case of Spain, which on the eve of the crisis appeared to be a model fiscal citizen. Its debts were low — 43 percent of G.D.P. in 2007, compared with 66 percent in Germany. It was running budget surpluses. And it had exemplary bank regulation.

Krugman describes the housing bubble that hit Spain so hard driven by lots of money flowing into the country. Then Spanish exports became uncompetitive as workers shifted over into housing (and likely finance as well). When the housing boom crashed so did tax revenues.

He blames Spain's milder version of Greece's sovereign debt problem on the bursting housing bubble and its aftermath.

Then the bubble burst. Spanish unemployment soared, and the budget went into deep deficit. But the flood of red ink — which was caused partly by the way the slump depressed revenues and partly by emergency spending to limit the slump’s human costs — was a result, not a cause, of Spain’s problems.

Okay, all plausible. He even says that if Spain had its own currency still it could loosen monetary policy to speed recovery. This might all be true. But where does Krugman go with this line of argument? Closer political union as the solution to the Euro problem:

Now, if Spain were an American state rather than a European country, things wouldn’t be so bad. For one thing, costs and prices wouldn’t have gotten so far out of line: Florida, which among other things was freely able to attract workers from other states and keep labor costs down, never experienced anything like Spain’s relative inflation. For another, Spain would be receiving a lot of automatic support in the crisis: Florida’s housing boom has gone bust, but Washington keeps sending the Social Security and Medicare checks.

But Spain isn’t an American state, and as a result it’s in deep trouble. Greece, of course, is in even deeper trouble, because the Greeks, unlike the Spaniards, actually were fiscally irresponsible. Greece, however, has a small economy, whose troubles matter mainly because they’re spilling over to much bigger economies, like Spain’s. So the inflexibility of the euro, not deficit spending, lies at the heart of the crisis.

This argument is very wrong and very ivory tower. Why would a much closer political union solve economic problems in Europe's labor market? Think about it. European people can't migrate around the continent in huge numbers on the scale that Americans do because they speak different languages and have much more distinctive national cultures. The huge US migrations into Florida, Nevada, and other recent targets of inward migration were possible because when people got out of their cars and applied to work at banks, gas stations, stores, mortgage companies, government offices, and large numbers of other businesses the people interviewing the job applicants spoke the same language.

Get down to the level at which an economy functions and we see some movement of upper managers and engineers who all can speak English together. Also, we see movement of people who can work in construction teams where foremen can be bi-lingual. But this approach doesn't scale up to an entire economy - at least not efficiently.

The single currency for both southern and northern Europe was a bad idea that is not fixable. It will continue to cause serious problems for decades to come.

I do not have a solution to offer on Europe. Pulling a few nations out of the Euro might well cause an even bigger recession. But leaving them in will set the stage for more sovereign debt crises and popular unrest.

Update: The US had a real estate bubble in Florida, Nevada, California, and Arizona. A political union didn't prevent it. We handled it differently (not clear if better) because the Federal Reserve doesn't share the attitudes of (heavily German influenced) European central bankers. We also have a much greater sense of shared nationhood because we've been a nation for over a couple hundred years. We could absorb European immigrants gradually into an existing culture. Trying to negotiate a common culture between rival nations is a far far larger job - an idea that only out-of-touch elites (hello Mr. Krugman) would entertain.

The European Monetary Union is threatened by the threat of default on growing public debts in Greece, Ireland, Spain, and some other spendthrift European countries. Der Speigel takes notice.

Practically unnoticed by the public, an issue has returned to the forefront in recent weeks -- one that was a cause for great concern at the height of the financial crisis but then, as optimism about the economy began to grow, was eventually forgotten: the fear of a national bankruptcy in the euro zone. And the question as to whether such a bankruptcy, should it come about, could destroy the common European currency.

Greece was always at the very top of the list of countries at risk. But now the danger appears to be more acute than ever.

Greece could conceivably exit the Euro and bring back their drachma if the crisis hits an acute state where the Greek government loses the ability to refinance debt at affordable interest rates. This crisis looks set to get worse before it resolves. The Greek sovereign public debt shows America her future.

Brussels says Greece's public debt will rise from 99pc of GDP in 2008 to 135pc by 2011, without drastic cuts. Athens has been shortening debt maturities to trim costs, storing up a roll-over crisis next year. Some €18bn comes due in the second quarter of 2010 (IMF).

America's fiscal path is more like that of irresponsible southern European countries than like that of the staid solid Germans. We can watch how events play out in other reckless spending countries to get a taste of our future.

The European Commission projects Greece's 2009 budget deficit at almost 13% of gross domestic product, versus an EU average of just under 7%. Greek government debt, currently about 112% of GDP, probably will balloon to 130% before stabilizing, Fitch said.

Fitch cut Greece's rating a notch to BBB+, still within investment grade, citing its lack of decisive action to rein in the deficit. High debt and a sluggish economy are shared by Portugal, Ireland and Spain, creating a risk of contagion if investors flee Greek assets.

"This raises question marks over the long-term viability of the euro's current membership," said Simon Tilford, chief economist at the Center for European Reform, a London think tank. "On current trends," he added, "we'll end up with economic stagnation and mounting political tensions in the euro zone, and, at worst, fiscal crises and a loss of political support for continued membership."

Dec. 11 (Bloomberg) -- Greece and Ireland are among countries in an “intolerable” economic situation, which may lead to bailouts or even an exit from the euro area by the end of next year, according to Standard Bank Plc.

On Thursday, the risk premium that investors demand for holding 10-year Greek government bonds rose again by 0.13 percentage point to 2.50 percentage points over German government bonds, which are seen as safe, according to Barclays Capital. This spread — a key gauge of market fears — has jumped 85% since Nov. 12 and hasn’t been this high since April.

The Spanish and Portuguese interest premiums are substantial but small in comparison.

Thursday, the so-called “spread” between Spanish and German government bonds widened 0.04 percentage point to 0.66 percentage point, while the spread on Portuguese bonds versus German debt is 0.075 percentage point wider to 0.77 percentage point.

...

The spread between Ireland’s government debt yields and the German equivalent widened further by 0.105 percentage point to 1.80 percentage points.

"The current situation in Greece shows the problems created by a single currency," says Martin Feldstein, a Harvard University economist who is perhaps the euro's most prominent skeptic.

...

"The single currency enabled Greece to issue enormous amounts of government debt until it reached the current crisis level," Feldstein said in an e-mail interview.

Will the Germans bail out the Greeks in order to protect the monetary union? I do not see how that can solve the problem without a simultaneous large scaling back of the size of Greek government. How will this crisis resolve itself?

First off, the "oh, it's only Greece, it's only small" argument falls apart. As currencies analysts at Commerzbank said Wednesday, "the euro zone is only as strong as its weakest link."

A high trust high social capital society is a precious vulnerable thing to have (a point that pro-open borders libertarians and liberals do not understand). Greece has low trust and high contempt for government. One in four workers in Greece work for this government that most do not like.

The underground economy, which some estimates place as high as 30 percent of gross domestic product, helps people in countries like Greece that have European prices but salaries below the European average.

As he sat in a cafe with friends in the chic Kolonaki area on a recent afternoon, Antonis, 33, who disclosed only his first name, proudly announced that he refused to pay taxes.

“Why should I pay?” he asked with a grin. “I don’t care about my government; I don’t care about my country,” he added. He conceded, however, that he did care about soccer and women.

Credit-default swaps, contracts investors use to protect against non-payment of debt, show Mexico trading as high-yield, or junk -- placing it three levels below the nation’s BBB+ grade from Standard & Poor’s and Fitch Ratings -- on concern the tax increases will fail to stave off downgrades.